Weather warning

Insurers stand to lose more than most if the predictions on climate change hold true. Ashley Prebble and Natalie Perkin report on the industry’s response to the scientific evidence

Scientific consensus on climate change presents us with the stark reality of a serious global problem. Whether one accepts that the problem is caused by carbon emission levels, a natural cycle in temperature fluctuation or a combination of the two is arguably superfluous to the issue. Sea levels are on the rise; storms are forecast to gain in frequency and severity; and floods, heat waves and droughts all pose an increasing threat.

UK Environment Secretary David Miliband summed it up when he said: “With climate change we can’t just close our eyes and cross our fingers… and time isn’t on our side.” The world and its economy needs to respond, and none more so than the insurance industry, whose risk of exposure could rise at a proportion exponential to the rising level of the sea. So what are the consequences of the progressively louder call for action and what response are we seeing from the industry?

Capacity and affordability

If we see a dramatic increase in natural catastrophes and associated losses, the insurance and re-insurance industry faces a mammoth strain on its reserves. With Hurricane Katrina losses estimated to be at least $40bn (£19.65bn) and an active 2007 hurricane season forecast, a major challenge to the market will be ensuring that it has the financial capacity to meet such risk.

If substantial losses become commonplace, insurers might find need to hold more capital in order to write certain classes of risk. In some eventualities, and in order to mitigate the social, commercial and economic dangers of premium increases exceeding affordability, governments are being considered as step-in insurers.

Further pressure is mounting on insurers to adapt their risk assessment/catastrophe modelling strategies to take into account scientific research, as climate extremes over time become easier to measure. Sea levels and the influence of ocean-surface temperatures, for example, could be factored in. Adapting and refining such strategies, however, inevitably comes at a cost of its own and the volatility of the subject matter might make it an unachievable task.

Consequently, insurers are actively seeking to diversify risk and grow their market share through premium and investment income. Investment choices are important, as the footprint of climate change will vary regionally and ‘non-green’ industries may be less profitable over time. There are also calls to reject investments in environmentally irresponsible corporations, and the risk of vicariously inheriting a bad reputation should not be overlooked.

Redrafted policies

Policies are being redrafted to meet new demands. Directors’ and officers’ policy wordings, for example, should be revisited to consider the exposure of directors and officers to environmental liabilities. The Companies Act 2006 will impose statutory obligations on directors to consider the impact of business decisions on the environment.

Furthermore, the act imposes duties on listed companies to report on environmental impact. April 2007 also saw the deadline for implementation of the Environmental Liability Directive in the UK, which adopts a ‘polluter pays’ approach to environmental damage. As a result, policy wordings on environmental impairment liability will need to be brought into line.

Growth in offsetting

Policyholders are increasingly able to offset their carbon emissions for an additional premium. Motor insurance purchasers, for example, can offset their emissions – based on the size and type of their engine and their estimated mileage – for the term of the policy. Insurance companies are similarly opting to offset their own carbon footprint in areas in which emissions are harder to reduce. Offsetting (together with carbon credit trading, discussed below) aligns itself with the Government’s draft Climate Change Bill (March 2007), the first of its kind to suggest that legally binding ‘carbon budgets’ will be imposed, enforcing a 60 per cent reduction in the UK’s carbon emissions by 2050.

Trading solutions

Carbon credits are granted under international agreements such as the Kyoto protocol and allow businesses to emit certain levels of greenhouse gases. By trading credits, a business that cannot reduce its own emissions can pay another business to make the reduction by purchasing the other business’s surplus credits.

Premium reductions

Insurers are also examining reward or incentive-based products that encourage policyholders to act responsibly in return for a reduction in premium.


Climate change is not going away. The increase in frequency and intensity of extreme weather-related events will have a far-reaching impact economically and socially, and a substantial risk lies with the insurance industry. The regulatory horizon is constantly evolving; the introduction of domestic and European legislation, the establishment of the UN inter-governmental panel on climate change, the G8 in June 2007 and the successor to Kyoto set for December 2007 highlight the level of seriousness attributed to the issue.

A closer relationship between insurers and governments, remodelling, continued scientific research and product innovation are some of the responses currently debated by the industry. The increasingly prominent view emphasises the need to act now, as “it is not acceptable to wait until the effects of the trend are well understood” (Lloyds ICA guidance 2006). Taking action is clearly the key.

Ashley Prebble is a partner and Natalie Perkin an associate at Norton Rose